Will France be the next euro nation to fail?

ByRichard Lee, Guest bloggerDecember 22, 2010

Passengers waits on a baggage carousel at Orly Airport, south of Paris, Dec. 20, because snow and freezing temperatures caused holiday travel chaos in much of Europe. France's economic recovery is also in a deep chill, causing some worries about the nation's debt.

Europe is falling apart and economies both small and large aren’t immune to fears of a meltdown. While Spain and Italy are getting the most attention, you also need to pay attention to France. With the country’s negative economic numbers and wide exposure to both Greece and Spain, the future doesn’t look good for Les Bleus, which is even worse news for the euro (EUR).

Not surprisingly, the markets are in agreement with this bleak picture. The cost for insuring French debt soared to a record on December 20 – rising above insurance costs for the Czech Republic and double that of Europe’s largest economy, Germany.

Since the beginning of the year, the French economy has just barely crawled along. Growth has been kept to a minimum, with quarterly gross domestic product figures barely above 0.5%. Together, this is making for a pretty poor annual performance. The French economy is expected to expand by a low 1.4% this year – much lower than the 2% growth rate in the United States.

Even worse is the fact that the country’s recovery is lagging far behind Europe’s other two powerhouses – Germany and the United Kingdom. Both countries have bounced back better than France, even as their governments raise taxes to offset government spending. Market analysts estimate a rapid 3.7% pace of growth for Germany and a 2% expansion for England.

Part of France’s problems can be found in its manufacturing and service sectors. Although the country’s manufacturing activity has been stable, it’s barely growing. The service sector is worse. According to government statistics, sector activity peaked in May and has steadily been declining ever since – hovering just above break even last month.

This slower-paced recovery has resulted in a relatively high rate of unemployment. True, joblessness isn’t as bad in France as it is in Greece, Spain or Ireland. But it’s still very high – 9.3%, representing 2.6 million people out of work.

So it’s no wonder that consumer sentiment is down. According to the latest polls on the consumer outlook, the French don’t think too highly of the future. Although the index increased over the last couple of months, it remains more than three times more pessimistic than the rest of Europe.

And if all of that weren’t bad enough, you also need to consider France’s ties to Greece and Spain.

According to a report published by the Bank for International Settlements, French banks ranked first when it came to exposure to Europe’s peripheral markets – Greece and Spain. The June 2010 report showed French banks holding about $500 billion, or 31% of the total $1.58 trillion European Union debt load. Approximately 80% of these loans were geared toward private sector projects and not public works.

This means there may be a higher probability of default since corporate entities – not state governments – make up the majority of the outstanding loans. Obviously this eats away at banks’ capital foundation.

French loans to Greece and Spain account for 8.3% of the banks’ Tier 1 capital – or the core strength of a bank. This figure is enormously high. For comparison, it’s four times more the UK bank exposure to those countries, and more than eight times that of US banking exposure to the same.

That means French banks would suffer heavier losses than most banks in the world if these countries outright failed or went bankrupt.

Now, I’m not saying it’s the end of France or the end of Europe. But with French economic fundamentals in the gutter and its deep bank exposure to some of Europe’s most troubled nations, we can’t expect any massive appreciation in the underlying euro currency till next year.

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